Are bitcoin investments safe from tax bites?

The plunges in bitcoin and other cryptocurrencies in recent weeks have been a harsh lesson for many trend-chasers. But as painful as those were, market losses aren’t the only thing they should be braced for. Daniel Ling, tax specialist at Crowe Soberman LLP, said the Canada Revenue Agency (CRA) would likely want to step in and take a hard look at your cryptocurrency.

In a recent note, Ling said that tax consequences can arise from cryptocurrencies depending on two critical questions: how they were acquired and the owner’s intentions in holding them.

In cases where cryptocurrencies are acquired through mining, the CRA will have to determine whether the mining was done as part of a business or simply as a hobby. There’s no definitive test or criteria, so at the moment the CRA looks at the facts surrounding each case individually. In case the activity is declared and deemed as a hobby, income would not be taxable when received but would be taxable when disposed.

“At the moment, the CRA has not released the specifics on how and when the revenues from mining businesses will be taxed,” Ling said, though he added that those in the business of cryptocurrency mining would report their business’ details on Form T2125, Statement of Business or Professional Activities.

Just purchasing bitcoins or similar digital currencies would not lead to immediate tax consequences. But when cryptocurrencies are accepted in exchange for goods or services, barter transaction rules would apply; the CRA would tax the party receiving the cryptocurrencies based on either the usual monetary value of the good or service they delivered or, if that information’s not available, the value of the cryptocurrencies they received. Ling noted that since volatility in a cryptocurrency could make determining a sufficiently accurate average price difficult, it is best to use the price at which a purchase or sale has been settled at, or its value at the time the transaction was executed.

In cases where cryptocurrencies are being traded, the CRA would also have to make a judgment on whether they are being held as investments or inventory. There are no definitive thresholds or tests, though the agency may take factors such as the frequency of transactions, period of ownership, the owner’s knowledge of the securities markets, and time spent into account.

When cryptocurrencies are regarded as investments, gains or losses would count only when they have been disposed, usually through a sale or exchange. “Only half the resulting gain or loss is included into income as a taxable capital gain or an allowable capital loss, respectively,” Ling said.

“[Cryptocurrencies] are generally considered to be held as inventory and on account of income when the course of conduct in trading or selling … resembles a business,” he said. The inventory valuation method to account for the cryptocurrencies has potential revenue consequences each year, with gains or losses on disposed cryptocurrencies being treated as ordinary income and fully taxable. Trading business information, as well as any reasonable expenses in operating such a business, would be reported on Form T2125.